The importance of a working capital analysis in a transaction
A successful business acquisition or sale requires a thorough financial analysis. An important part of this is the working capital analysis. This analysis is necessary in determining shareholder value, or the price paid for a company's shares. In this blog, we discuss the meaning and importance of a working capital analysis in M&A (Mergers & Acquisitions) transactions.
What is a working capital analysis?
Net working capital is the difference between current assets (such as inventories and accounts receivable) and current liabilities (such as accounts payable). It is an important measure of a company's financial health. It also provides insight into how well a company is able to cover its daily operating costs. During a working capital analysis, the course of working capital is analyzed on a monthly or daily basis over an extended period of time. This allows the average level of working capital to be determined after this period.
From enterprise value to shareholder value
In an acquisition, the enterprise value (enterprise value) is often taken as the starting point. This is the value of the company, without taking into account how the company is financed (cash and interest-bearing debt). To get from enterprise value to actual shareholder value (the final purchase price), any excess cash must be added and interest-bearing debt subtracted.
A working capital adjustment can be part of the calculation of enterprise value to shareholder value. The average working capital level determined from the working capital analysis is compared to the working capital available at the time of sale. However, the balance sheet, which shows working capital, is only a snapshot in time. It does not take into account fluctuations that may occur during the year.
An example
For example, suppose a company is completely closed for the last two weeks of December. It is then very likely that, for example, the accounts receivable at the end of the year will be quite low, because nothing has been delivered for two weeks and therefore no new invoices have been sent out. At the same time, the bank balance will probably be a lot higher, because the older debtors will have paid by now.
If a buyer settles on the basis of such a balance sheet and no correction is made for the deviating debtor position and liquid assets, this could create an undesirable situation. After all, the buyer is paying for the higher cash position, but experiences that during January the accounts receivable position will gradually rise again, which will have to be pre-financed by the company, as a result of which additional cash may be required.
Therefore, to arrive at a fair purchase price, a working capital adjustment is applied in many cases. The working capital adjustment is determined by comparing the actual working capital position at the time of sale with a pre-agreed "normal" or "average" working capital position. If a discrepancy is found, it is corrected. If the balance sheet shows lower-than-average working capital, this can result in a negative working capital adjustment. Conversely, if working capital is higher than normal, this may result in a positive correction.
How Florijnz supports companies with working capital analyses
At Florijnz, we understand the importance of a thorough working capital analysis in the acquisition process. With our extensive experience, we help companies get a clear picture of their working capital position. We also ensure that fair and well-founded negotiations take place. This prevents unexpected financial setbacks after the transaction.
Want to learn more about how a working capital analysis can support your business during a transaction? Feel free to contact us for a no-obligation discussion.
